Discussion: Unrealistic Assumptions of Cost Volume Profit Analysis

This discussion post critiques the assumptions of Cost Volume Profit (CVP) analysis, arguing that they are often unrealistic and limit the analysis's practical application. The post highlights several key assumptions, including constant inventory levels, a constant variable cost per unit, the ability to classify all costs as fixed or variable, and linear cost behavior. It argues that these assumptions do not hold true in real-world scenarios due to factors such as fluctuating inventory levels, efficiency gains, the difficulty in categorizing all costs, and non-linear cost relationships. The post emphasizes that these simplifications can undermine the reliability of CVP analysis in decision-making. References from McLaney and Atrill (2014) and Dayananda (2012) are included to support the arguments made in the discussion.

CVP 1
Cost Volume Profit (CVP) Discussion
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CVP 2
Cost Volume Profit (CVP) Discussion
The assumptions made in cost volume profit (CVP) analysis are unrealistic and do not typically
hold in real life. Consequently, CVP analysis cannot reliably be used in practice. This paper
highlights some of the unrealistic assumptions and simplifications made in CVP.
One of the assumptions is that inventory levels remain constant from one period to another
(Dayananda, 2012). This implies that opening and ending inventory values do not change. In
practice however, opening and ending inventories vary based on anticipated demand for the next
period among other factors.
The second assumption made in CP analysis is that that variable cost is constant for every unit.
In practice however, efficiency gains and economies of scale are realized as production volume
increases. The effect of these gains would be a reduction in variable cost.
The third assumption made in CVP analysis is that all costs can be designated as fixed or
variable (McLaney and Atrill, 2014). Without this classification of costs, CVP analysis is
impossible. In practice however, it is difficult to accurately distinguish fixed costs from variable
costs. Additionally, costs in certain circumstances may not be classified as purely fixed and
variable. Certain production processes have step-fixed cost behavior.
A further assumption made is that costs are going to be linear within the designated range. In
practice however, cost behavior may not remain constant. The effects of bulk discounts and
economies of scale make cost relationships to be non-linear.

CVP 3
Reference List
McLaney, E. and Atrill, P. (2014). Accounting and Finance: An Introduction. Harlow: Pearson.
Dayananda, D. (2012) Capital Budgeting: Financial Appraisal of Investment Projects.
Cambridge: Cambridge University Press